Archimedes famously noted, “Give me a lever long enough and a place to stand and I will move the world.” If Archimedes were alive today, he might use his savvy to leverage the smallest of margins and make trillions as a fund manager. Or fashion another Eureka moment when he figured out that now is a good time to short-sell the long bull market and make a few trillion more. So what if more people live in poverty than at any time in history, while more than 40% of all corporate profits go to the financial industry? What’s another trillion to a smart guy?
Smart guys have been making money ever since they learned how to tweak information to their advantage. In the early 1800s, the Rothschild family used their fraternal network to accumulate the largest fortune ever. Niall Ferguson noted in The Ascent of Money that the Rothschilds knew the outcome of the Battle of Waterloo two days before the British cabinet did and, more importantly, before the bond-buying public. Strategically placed around Europe, four brothers took advantage of slow news trickling through inefficient channels to make a killing. Remember The Sting, when Paul Newman and Robert Redford played Robert Shaw for a chump by setting up a delayed wire fraud? To the insiders go the spoils.
To be sure, who you know trumps what you know, but old-fashioned ingenuity is required for most regular Joes. In 1873, Joseph Jagger bested Monte Carlo after he figured out that one of their roulette tables was improperly balanced. He racked up a sizeable wad ($6 million in today’s money), before the casino bosses cottoned on and changed the location of the wobbly wheel; Jagger soon started losing as per the standard 7.7% house rate. In 1892, Karl Pearson advanced the mathematics of bias using repeated roulette data, the chi-squared test for randomness and a correlation coefficient named after him. At least, some greater good came of wanting to divine the mathematical odds of where a spinning ball might land on average.
In the early 1960s, making the serious money required a computer, that is, for the smarty pants in university mathematics departments with preferred access, such as Edward Thorp, who first applied his number-crunching acumen to the Blackjack table. Using computers at UCLA and MIT, Thorp ran his mammoth iterations to work out the odds of every possible dealer-player configuration, for example, calculating that it is better to stick with a 12 against a dealer’s 6. It’s called a Monte Carlo simulation, sheer brute numerical force, used today to predict weather patterns, calculate the motion of a nucleus in a DNA sequence, even to improve car and airplane safety.
Thorp’s book Beat the Dealer changed the casino for the informed player, and he soon applied his advanced smarts to the market. In The Quants, Scott Patterson’s book about how quantitative analysts almost destroyed Wall Street, he noted that in the shadowy world of warrants, Thorp “stumbled upon a gold mine full of arbitrage opportunities,” devising a formula to bet on both sides of what would become known as convertible bond arbitrage, “one of the most successful and lucrative trading strategies ever devised.”
The really smart guys who knew the mathematics flocked to the financial world, amassing unheard of amounts of wealth and carting their winnings to the banks in U-hauls. Money was all that mattered, more than product or people, the market now an alchemist’s dream to wring every last penny out of another’s less efficient investment strategy.
Others have applied their formulas and educated guesses to make their killings. In 1992, George Soros made almost $2 billion in a single currency speculation when he bet against the British pound. In the midst of the 2009 American mortgage market meltdown, John Paulsen bet against the bloated American real estate market and made $1.25 billion in a single day and ultimately $4 billion over the course of the crisis. Soon after, home foreclosures hit all-time highs.
It’s not all glory though, perhaps why we still think of the market as a game. As part of the Long Term Capital Management hedge fund, Robert Merton and Myron Scholes used their academics smarts to make more than a trillion in credit default swap derivatives, that is, until Russia defaulted on its bonds and brought LCTM down with it. They did however get an Economics Nobel for their troubles.
Not all divinations are legal, though one wonders how some of the more obvious schemers can get away with their scams. Former NASDAQ stock exchange chairman Bernie Madoff ran a $50-billion Ponzi scheme for decades without one losing quarter. In No One Would Listen, Harry Markopolos noted that enormous gains kept coming in but no one wanted to ask questions: “They never bothered to look a little deeper to see if he was cheating other clients—like them for example. What they didn’t understand was that a great crook cheats everybody.”
In Empire, Ferguson noted about another Rothschild family shell game, where they lent funds to the British prime minister of the day to purchase stock in the Suez Canal, from which a capital gain of more than 130 per cent accrued. It little mattered the conflict of interest or that the public was in the dark. The mix of politics and insider trading continues to this day, including in the U.S. Senate where as Ann Woolner reported, “72 congressional aides from both parties made trades in companies that their bosses’ help oversee.” (The Wall Street Journal, October 14, 2010). The regular citizen seems always to be on the outside.
The smart guys at Goldman Sachs helped Greece massage its wobbly finances, thus aiding in its calamitous course. They also had enough friends in high places to receive a $6-billion government bailout during the global credit meltdown yet still managed to pay almost $3 billion in bonuses. Who you know, what you know, and how you can make more money than dreamed of, no matter the consequences.
The favourite parlour game today is the foreign exchange market, once a simple mechanism to protect a company’s international exposure against unforeseen events. Now, it’s a five-trillion-dollar-a-day crap shoot, using the latest fancy algorithms, aided and abetted by the Fed and ECB if you’re smart enough.
What’s more, speed is everything, transactions made in seconds using the latest computers. Day or high-frequency trading is the buying and selling of a stock, not for investment purposes, but to bet on the short-term rise and fall of stocks. In How The West Was Lost, Dambisa Moyo noted that “high-frequency trading accounts for as much as 73 per cent of US daily equity volume, this figure being up from 30 per cent in 2005.” The so-called 2010 “flash crash” that saw the largest 1-day Dow Jones loss (9%) was also been blamed on high-frequency trading.
Adam Smith knew that people mattered in his calculations, despite the impersonality of assembly-line efficiency, but his sentiments have been ignored in favour of cut-throat competition and supposed innovation. His invisible hand was meant to guide all wills, but has become a strapped-on prosthetic used to explain capitalism as an effortless rule of nature, as though preordained, where talent and determination win out.
In fact, there is a basic lack of empathy, as if playing a children’s board game where winning is all that matters. Weren’t we supposed to put way childish things as we became adults and think about our relationship with others? Is being number one on the Forbes List a success or, indeed, a failure of our times? Imagine having $56 billion (the average of the current top 10) when more than one billion people live in abject poverty, when thousands die daily from malnutrition, neglect, or unfortunate disaster. New Jersey Senator Loretta Weinberg went so far as to refer to Madoff as a “sociopath with no sense of values.” You can’t take it with you, though cryonics hopeful Edwin Thorp hopes he can at least come back some day to spend it.
Thankfully, the math men aren’t all so selfish. Some have applied their trade to the rip-off world around them, such as Henri Poincaré who realized he was getting 950 grams in his daily bread loaf instead of the advertised 1 kg, which helped to advance probability theory. Adolphe Quételet saw that there were 2,200 more short men than expected, all hoping to dodge enlistment into Napoleon’s army. As Leonard Mlodinow noted in The Drunkard’s Walk, there was an absence of randomness, which has been used today to reveal bias in backdated stock options and a point-shaving scam in almost 70,000 college basketball games.
As we face extraordinary challenges of inequality, global indebtedness, and staggering world poverty amidst obscene wealth, we must decide if we want to maximize financial gains for the already wealthy or improve the life of those with none. Is selfishness to be rewarded? Do GDP and bond yields mark the health of a person, a nation, a world?
Greed is not good. It is not evolutionary, efficient, or right. Greed is bad, and it’s destroying our world. If only I had a lever long enough.
JOHN K. WHITE, an adjunct lecturer in the School of Physics, University College Dublin, and author of Do The Math!: On Growth, Greed, and Strategic Thinking (Sage, 2013). Do The Math! is also available in a Kindle edition. He can be reached at: firstname.lastname@example.org.